Financial guaranty insurance played an important role in the municipal bond market during the years up to the financial crisis, covering over 50 percent of new issuance at its peak in 2005. During the financial crisis, the seven AAA/Aaa financial guaranty insurers which dominated this industry all lost their AAA/Aaa status. We study the effect these downgrades had on yields in the municipal bond market, both on insured debt and uninsured debt, by analyzing market prices around the dates of significant events. We also examine changing patterns in issuance in the municipal bond market which may be attributable to the lack of AAA insurance.
Preliminary findings are that yields were volatile on both insured and uninsured municipal bonds during the height of the crisis, driven more by wholesale reaction to market events than nuanced responses to specific news about certain insurers or municipalities. Since the insurers' financial strength fell as the markets weakened, the insurance did not protect insured bond investors from market turmoil. Since the crisis, data compiled suggests insured bonds have been trading at discounts to uninsured bonds.
Su Huang and Catherine Lau. "Performance of Insured Bonds after the Insurers' Downgrades: Some Preliminary Results." Proceedings of the New York State Economics Association. vol. 5, October 2012, p. 65-71
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